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Bate C. Toms
Managing Partner, B. C. Toms & Co.
Legal education: Yale Law School (J.D.), Magdalene College, Cambridge University (Law Tripos I); Mr. Toms is admitted to legal practice in the District of Columbia and Virginia, USA, and in Paris, France; Chairman, British Ukrainian Chamber of Commerce (BUCC)
Associate, B. C. Toms & Co.
Legal education: Kyiv National Linguistic University, Law Faculty,
Associate, B. C. Toms & Co.
Legal education: Queen Mary University of London
(Bachelor of Laws with Honours)
The Key Changes in the Energy Sector Legislation
This Article reviews (1) modifications for 2019 of the tax regime for oil and gas production, (2) changes to the “green” energy market in Ukraine and (3) recent legal developments affecting oil and gas operations.
1. Tax Regime for Oil and Gas and Other Energy Production
Law No. 2628-VIII of 23 November 2018, On Introducing Amendments to the Tax Code and Other Legislative Acts of Ukraine Regarding Improvement of the Administering, and the Revising of Some Rates, of Taxes and Charges, introduced amendments to the Tax Code of Ukraine (“Tax Code”) to apply the following changes to the oil and gas rental fees on production from 1 January 2019:
(1) 31% for oil and condensate production from deposits that completely or partially lie at depths of up to 5,000 m, and 16% for oil and condensate production from deposits that completely lie at depths exceeding 5,000 m;
(2) 12% for gas produced from new wells from deposits completely or partially at depths up to 5,000 m, or 6% from depths exceeding 5,000 m; and
(3) 2% for oil and 1.25% for gas, respectively, produced under production sharing agreements (“PSAs”).
In principle, such legislation modifying tax rates should be invalid for the next tax year because it was adopted within six months before the beginning of this next tax year, in violation of Article 4(1)(9) of the Tax Code. It seems surprising that the legislation on rental fees has again been adopted in violation of this well-known legal principle under the Tax Code, and it can be expected that those rental fee rates that have been increased will be challenged in litigation.
2. Legislative Changes Governing the Operation of the “Green” Energy Market
2.1. The Shift to an Auction System for Renewable Energy Sources
For a number of years, the energy sector in Ukraine has been trying to foster by subsidies the growth of electricity production from renewable energy sources (“RES”), while trying to ensure that the producers are not over — compensated. Ukraine currently has the highest “green” tariff in Europe, which is surprising considering the substantial cost reductions for RES technologies in recent years and the significant imbalance between the RES energy produced and the compensation paid. In 2018, only approximately 1.5% of the total amount of electricity produced was from RES, for which approximately 8.2% of all energy payments were made.
Law No. 2712-VIII, On the Introduction of Certain Changes to Laws of Ukraine Regarding Ensuring Competitive Conditions for the Generation of Electricity from Alternative Energy Sources, of 25 April 2019 (the “New Energy Law”), provides for a gradual shift from a tariff-based subsidy system to a more competitive and diverse structure, with yearly quotas being allocated through auctions. Power purchase agreements under the New Energy Law will be signed for a 20 year term, starting from the date of the facility entering into operation, under which the guaranteed buyer (currently the state company Energorynok) will have to buy the energy produced at the price and in the amounts set during the auctions.
2.2. The Gradual Replacement of “Green” Tariffs by an Auction Based System
While the current “green” tariffs will stay in force until 2030, as provided for by Law No. 2019-VIII, On the Electricity Market, of 13 April 2017 (the “Electricity Market Law”), from 1 January 2020 they will be 25% and 10% lower for solar and wind energy, respectively, with the existing 5% to 10% bonus for using domestically produced equipment being preserved.
From 1 January 2020, selling RES electricity producers will have to participate in auctions, for which annual quotas will be allocated to those producers offering the lowest price. Such annual quotas must be established by the Cabinet of Ministers of Ukraine (“Cabinet of Ministers”) to last for periods of five years for three separate categories, being wind, solar and other types of RES electricity. The first pilot auctions, scheduled to start from 1 July 2019, will probably be delayed because on 10 June 2019, the President proposed to postpone such auctions and other initiatives until July 2020, to obtain more time for better implementation.
Under the Ukrainian Strategy statement, “Safety, Energy Efficiency, Competitiveness”, adopted on 18 August 2017, it is intended for RES electricity consumption to reach an 11% market share by 2020.
2.3. Key Conditions for Auction Participation
The RES electricity companies that may participate in the said auctions are limited, for 2020, to only those wind energy plant producing more than 20MW and to other types of RES plants producing more than 10MW. In 2021 and 2022, this capacity threshold will be the same for wind energy plants, but lowered for all other RES types to 5MW. After 2023, wind energy plants will be required merely to meet a minimum criterion of 3MW, and for all other RES types a minimum of 1 MW. No participant of an auction can be allocated more than 25% of the total annual quota, with this limitation being applied by aggregating participants that have the same ultimate beneficial owner.
2.4. Conditions for Using the Existing “Green” Tariff Instead of the Auction System
RES electricity companies will not have to participate in auctions if they are (1) currently benefiting from the existing “green” tariff, or (2) intending to do so and will go into operation by the end of 2019. Another option to use “green” tariffs instead of the auction system is for such RES companies to sign preliminary agreements with Energorynok by the end of 2019 and commission their facilities within two years thereafter for solar, or three years thereafter for all other RES types. Where a company completes construction of its RES facility after 1 January 2020, and has insufficient energy capacity to meet the auction requirements, it will still also be able to use the “green” tariff.
3. Developments Affecting Oil and Gas Operations
3.1. E-Auctions of Subsoil Use Licenses
Cabinet of Ministers Resolution No.848, On the Implementation of an Experimental Project on the Introduction of Auctions for the Sale of Special Subsoil Use Permits through Electronic Auctions, of 17 October 2018 (the “Resolution”), provides for a transparent and simplified procedure for the sale of special permits for subsoil use (“Subsoil Licenses”) on internet based electronic auctions (“E-Auctions”). These E-Auctions are handled by the State Geology and Subsoil Service of Ukraine (“Derzhgeonadra”) through the “ProZorro” system, the online public e-procurement bidding system developed in Ukraine that is recognized as being among the world’s most transparent. E-Auctions are open for participation by Ukrainian companies and individuals that submit an application within 90 days following the official announcement for a particular E-Auction. The highest bidder wins the E-Auction, provided only that the price for the Subsoil License has been raised at least once. The first two such E-Auctions were successfully held on 6 March 2019 and 2 May 2019.
Under Law No. 2545-VIII of 18 September 2018, On Ensuring Transparency in the Extractive Industries, participants in auctions as well as those participating in PSA tenders (described below), must disclose their ultimate beneficial owners and the material terms of their agreements for extractive business.
3.2. PSA Tenders for Oil and Gas Fields
On 18 December 2018, the Cabinet of Ministers passed field-specific Resolutions, numbered from 1178 to 1181, providing for tenders for the sale of 12 oil and gas fields under PSAs, subject to the following conditions: (1) the term for each PSA should be 50 years (unless otherwise agreed by the parties); (2) the deadline for submitting an application to participate in a tender shall be three months following its official announcement; and (3) the State’s share in each PSA should be at least 11% of the total production volume, with the investors entitled to a maximum share of up to 70% plus cost recovery. The winner is determined based on several criteria, including the proposed environmental protections measures, the level of the State’s share in the production, and the amount of the investment.